Question

Question 1.

A. Define the concepts of full-employment GDP, the actual natural rate of unemployment and the inflation rate target. Explain how macroeconomists use these concepts in order to evaluate the current state of the economy.

B. Is a country's GDP a good indicator of the welfare of its citizens? Explain your answer.

Question 2.

A. Describe the concepts of the "circular flow of income" through the economy and how the concept is related to the macroeconomic identity Y = C + I +G +NX.

B. State Oklun's law in words. Why is it called a law? Write down the equation for Oklun's law for the Canadian economy and then explain its implications for changes in the unemployment rate in Canada.

Answer 1

1.

A.

The natural rate of unemployment is the equilibrium rate of unemployment, ie, at natural rate there is no involuntary unemployment and those who want to work at prevailing market wages have find their jobs. The output that an economy produce with the natural rate of unemploymnet or full employment is called the full employment output.

The equilibrium in the economy occurs where demand for real GDP equals supply for real GDP. That is where the demand curve intersects the supply curve. There are two supply curve in the economy they are short run aggregate supply and long run aggregate supply curve. The short run aggregate supply is the upward rising curve given different quantity supplied at different prices. The long run aggregate supply is a vertical line giving the full employment level of real GDP whatever is the price level. Thus there are two equilibriums in the economy; one is short run equilibrium and other is long run equilibrium.

The short run equilibrium is unstable in nature. If the short run equilibrium occurs at the real GDP level less than the natural real GDP the economy would be producing a at less than its capacity and employing less labor there will be unemployment. This is called the recession. If the short run equilibrium occurs at the real GDP level lessgreater than the natural real GDP the economy would be producing a at more than its capacity and employing more labor there will be inflation. This is called the expansion.

Inflation rate target is the predetermined target of inflation rate in a calander year set by the Central bank. Any deviation from this set alarming massage and the bank takes decision accordingly. A inlfation higher than the target is ususally refers to unstable economy.

B.

The standard of living is the level of availability of goods and services that makes the life of each economic agent more comfortable, safer, and healthier. The standard of living can be measured through output per person. Therefore, the GDP per capita measured the standard of living of a country.

GDP is not a good measure for standard of living. This is because it has two problems:

• The GDP does not take into account the environmental quality. If the country has bad environmental condition, it does not matter how large the output per person might be, the standard of living will be very low.
• The GDP leaves out the non-market activity like working at home and self-services. If the same service is paid then it will be a increase in GDP. Like if one clean the house by herself then the GDP will remain unchanged but if the person pay someone to do the job for her the GDP will increase as it will be consumption expenditure of that person.

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